Today I am going to talk to you about the biggest change when moving from a sole proprietorship to a corporation in accounting records.  The main difference is that we no longer have an account for OWNER’S EQUITY.  We will change the Equity classification to STOCKHOLDER’S EQUITY.  So, now the accounting equation looks like this:

ASSETS  =  LIABILITIES  +  STOCKHOLDERS’ EQUITY

What are the accounts in Stockholders’ Equity?  There are 3 accounts:

CAPITAL STOCK – This is the dollar value of the shares of ownership (stock) that we sell to the investors and the public to increase the company’s Equity.

RETAINED EARNINGS – These are the dollars we earn (Net Income)and keep in this Equity Account.

DIVIDENDS:  These are the dollars we set aside to give to our investors as a reward for investing in our company.  Depending upon our net income for the fiscal period, we may choose to share part of our profit with our investors (shareholders) or we may not be able to if our profit is low.  Dividends is similar to the sole proprietorship’s Drawing account in that Dividends has a normal Debit balance and Dividends reduces stockholders’ equity.

READ YOUR ELECTRONIC TEXTBOOK CHAPTER 11 SECTION 3.

I will not discuss the account PAID IN CAPITAL IN EXCESS OF PAR at this time.

Each corporation has an elected Board of Directors which makes decisions for the company’s operations.  There are three steps to be followed when the Board of Directors decides to share a part of the net income with the company’s stockholders.  The example follows:

Our company’s Board of Directors decides to share a portion of the net income with our stockholders.  The dividend will be paid in four payments (quarterly) of $.05 per share that each investor owns.   We have sold 75,000 shares of stock.  To calculate the total of the entire dividend, multiply the number of shares sold (outstanding shares) times the 5 cents per share = $3,750.  So every 3 months the company will pay a total of $3,750 to be shared among our stockholders depending on the number of shares each stockholder owns.  There are 3 steps to make this happen in our accounting records:

Step 1:  The Board of Directors must   DECLARE A DIVIDEND (DIVIDENDS ARE NORMALLY DECLARED ON ONE DATE AND PAID ON A LATER DATE)

Transaction:   December 15 – Debit DIVIDENDS        Credit DIVIDENDS PAYABLE (an amount we owe)

Step 2:  Because stockholders can buy and sell their stock among themselves, our company must find out who the current owners are and will receive the dividend.  So the Board chooses one day in order to take ROLL.  So on December 31, we find out who the owners of our stock are on THAT DAY.   This is the list of the investors who will receive the dividend.  This does not require a transaction in our accounting books.  The list is given to our bank which acts as our trustee for the dividend.  The bank then issues the checks to the owners of the stock from the roll date (Dec. 31).

Step 3:  The company then records the payment of the dividend in the Cash Payments Journal.  Debit the liability:  Dividends Payable ($3,750) Credit Cash ($3,750).

NOW:  Complete Work Together 11-3 and On Your Own 11-3 and Application Problem 11-3  (short and easy problems).